A memorable British TV show called “The Prisoner” opened with a cry from the eponymous main character that, “I am not a prisoner – I am a free man.” To paraphrase Rep. Pallone at a recent hearing, “I am not a product – I am a free consumer.” This heartfelt cry was hurled specifically at credit bureaus, but it speaks to the paradigm-shifting transformation of finance now sweeping away long-cherished strategic assumptions. A recent McKinsey report urges banks to “reclaim their rightful ownership of the customer relationship,” but customers are now demanding to own themselves, policy-makers second that emotion, and platform companies are more than ready to let them do it. The only reason Amazon and its ilk may not do to banking, brokers, and insurers what they did to retailers and are about to do to grocers and pharmacies is the regulatory structure of each of these businesses. If and how it changes are the most critical strategic factors now facing finance.
The McKinsey report presents a clear forecast of how radically platform companies are already changing banking and how they could soon dominate any cherry-picked financial product ripe for their omnipresent networks of consumer and commercial customers. A recent Basel consultation presents a bleaker future for banks, finding that the future will most likely see them converted into distributional outposts, relegated to utility functions, or disintermediated into oblivion. Looking more generally at the future of all financial services as algorithms redefining risk and reward, the Financial Stability Board is charitable about the possible benefits of data-driven transformation, but nonetheless fearful about handing over the financial infrastructure to untested entities.
Some of these fears are surely because the FSB has yet to govern most fintech firms, but its analysis persuasively shows that risk long observed in traditional finance (e.g., from model correlation, fire sales) are at least as potent for non-banks. In fact, the FSB has one flat-out terrifying fear worth assessing in detail. Parse through all the usual global gobbledygook and the risk is real:
network effects and scalability of new technologies may in the future give rise to additional third-party dependencies. This could in turn lead to the emergence of new systemically important players. AI and machine learning services are increasingly being offered by a few large technology firms. Like in other platform-based markets, there may be value in financial institutions using similar third-party providers given these providers’ reputation, scale, and interoperability. There is the potential for natural monopolies or oligopolies. These competition issues – relevant enough from the perspective of economic efficiency – could be translated into financial stability risks if and when such technology firms have a large market share in specific financial market segments. These third-party dependencies and interconnections could have systemic effects if such a large firm were to face a major disruption or insolvency.
It’s of course true that very large banks, securities firms, and insurers aren’t exactly bullet-proof, so perhaps systemic risk won’t increase with a platform-company putsch, just move into new hands. However, none of these companies has ever had anything close to either a natural or unnatural monopoly, let alone posed an oligopolistic threat. In the EU and other regions with “national-champion” banks, there have long been such dominant layers. However, they were fully backed by taxpayers and thus presented and to a considerable extent still present a very different risk profile than Amazon, Alibaba, Google, Apple, or the telecom and other firms making huge strides in the global financial marketplace.
Of course, traditional providers feel all this hot breath. Many are thus “partnering” with smaller fintech companies in the distributional business model presaged by the Basel report. Right now, as Lending Club, SoFi, and other fintechs are experiencing acute growing pains, this may well seem a viable strategy – indeed, McKinsey urges it on the world’s banks in no uncertain terms.
But, this partnering approach is a strategy akin to the one carriage-makers chose when the first automobiles ventured on the road. Many believed new and old would thrive together, with carriage-makers building chassis, wheelwrights learning about tires, and leather-goods manufacturers doing up the seats to look just like the nicest possible brougham money could buy. This worked when autos were made in garages by Stanley Steamer and other start-ups. Not so much, though, when Ford figured out the assembly line and GM joined in controlling both manufacturing and distribution. When consumers claim rights to their data, can the assembly line for the most profitable financial products be far behind?